CHAPTER
19
CHAPTER CHECKLIST
When you have completed your study of this chapter, you will be able to
1 Describe a countrys balance of payments accounts and explain what determines the amount of international borrowing and lending. Explain how the exchange rate is determined and why it fluctuates.
A persons current account records the income from supplying the services of factors of production and the expenditures on goods and services.
An example: In 2007, Joanne Worked and earned an income of $25,000. Had investments that paid an interest of $1,000. Her income of $25,000 is analogous to a countrys export. Her $1,000 of interest is analogous to a countrys interest from foreigners.
Net interest and transfers from abroad are small and dont fluctuate much, so to study the current account balance we look at what determines net exports.
Net Exports
Private sector balance is saving minus investment. Government sector balance is equal to net taxes
minus government expenditure on goods and services.
Table 19.2 on the next slide shows what determines net exports.
rises, the quantity of dollars demanded decreases along the demand curve for dollars.
2. If the exchange rate falls,
the quantity of dollars demanded increases along the demand curve for dollars.
Other things remaining the same, the larger the U.S. interest rate differential, the greater is the demand for U.S. assets and the greater is the demand for dollars on the foreign exchange market.
rises, the quantity of dollars supplied increases along the supply curve for dollars.
2. If the exchange rate
falls, the quantity of dollars supplied decreases along the supply curve for dollars.
Market Equilibrium
Demand and supply in the foreign exchange market determines the exchange rate. If the exchange rate is too low, there is a shortage of dollars. If the exchange rate is too high, there is a surplus of dollars.
At the equilibrium exchange rate, there is neither a shortage nor a surplus of dollars.
The net return on the Canadian dollar deposit is 3 percent (5 percent minus 2 percent) a year. Interest rate parity holds.
This action of buying and selling currencies brings about interest rate parity.